IRA Stretched Trust

What Is an IRA?

Individual retirement accounts, or IRAs, were created in 1974 under the Employee Retirement Income Security Act, or ERISA, to help workers save for retirement on their own. At the time, many employers could not afford to offer traditional-style pension plans, leaving employees with only Social Security benefits for retirement. The new IRA accounts achieved two goals: providing tax-deferred retirement savings for those not covered under an employer-sponsored plan and providing a place for retirement plan assets to continue to grow when an employee changed jobs, via rollover to an IRA.

Who Can Own an IRA?

As the name implies, individual retirement accounts can only be owned by an individual. They cannot be held in joint name, nor can they be held by an entity, such as a trust or small business. Additionally, contributions can only be made if certain criteria are met. For example, the owner must have taxable earned income to support the contributions. A nonworking spouse can also own an IRA but must receive contributions from the working spouse and the working spouse’s income must meet the criteria.

Regardless of where the contributions originate, the owner must remain the same. Only certain ownership transfers are allowed to avoid a taxable distribution. If transferred to a trust, IRA assets become taxable as this transfer is seen as a distribution by the IRS. In addition, if the owner is under age 59.5 at the time of distribution, an early withdrawal penalty is imposed. The trust can accept IRA assets of a deceased owner, however, and establish an inherited IRA.

Advantages of Trust Beneficiary on IRA

Naming a trust as beneficiary to an IRA can be beneficial in that owners can dictate how their savings are used by beneficiaries. A trust instrument can be designed in such a way that special provisions for inheritance apply to specific beneficiaries. This can be helpful if beneficiaries have a large age difference, family issues exist or special needs must be addressed. Many people also believe the trust provides tax savings for beneficiaries, but that is rarely the case.

It is very important to carefully consider how beneficiaries take possession of the IRA assets and over what time period. Seek advice from a trust adviser well-versed in Inherited IRA language. To gain the maximum stretch option of distributing the account, the trust needs to possess specific terms such as “pass through” and “designated beneficiary.” If a trust does not contain provisions for inheriting an IRA, it should be rewritten or individuals should be named as beneficiaries instead.

Disadvantages of Trust Beneficiary on IRA

Though moving all assets into the name of a trust and designating it as the beneficiary on retirement accounts is commonplace upon establishment of the trust, the latter is not always a good decision. Trusts, like other nonindividuals that inherit IRA assets, are subject to accelerated withdrawal requirements, most often within five years from the original IRA owner’s death. Without the proper “pass through” terminology referenced above, stretching the withdrawals over a lifetime is not an option. Depending on the size of the account, this could leave a relatively large burden to beneficiaries. It is especially detrimental to eliminate the spousal inheritance provisions by naming a trust instead of a spouse.

While trusts offer streamlining in most estate planning areas, they can create more hassle, paperwork and even tax burdens for beneficiaries if named to inherit an IRA. Work closely with an estate planner, attorney and accountant, who are all knowledgeable about trusts and IRAs, to maximize your legacy.

Recent Posts

The information on this website is not an offer to sell or solicitation of an offer to buy an interest in any investment fund or for the provision of any investment management or advisory services. Wittman Capital Management Investment & Estate Counsel, LLC does not offer tax or legal advice. Individuals are advised to consult with their own CPA and/or attorney regarding all tax and legal matters.